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Freeport-McMoRan in a World of Debt

Written by: Marc Courtenay12/06/12 - 6:00 AM EST

Tickers in this article:
PXP FCX MMR BLK SCCO

NEW YORK ( TheStreet) -- I'm all for making smart acquisitions that are immediately accretive to earnings and diversifies a company's income streams.

But when it involves taking on a total of $20 billion in debt and paying rich premiums for the companies bought, I'm dubious at best.

The market's reaction to Freeport-McMoRan Copper & Gold (FCX) announcement that its made an offer to buy Plains Exploration & Production (PXP) for $6.9 billion in cash and stock was not what FCX was hoping for.

Shares of FCX ended the trading day on Wednesday down 16% at $32.16 while shares of PXP soared 23.44% to close at $44.50.

As if that wasn't enough excitement for one day, FCX also said it would spend $2.1 billion for McMoRan Exploraton (MMR) . FCX will also assume $11 billion of the debt of the acquired companies.

According to an Associated Press report released after FCX's press release, "The addition of the two companies will create a natural resources conglomerate with assets ranging from oil rigs in the Gulf of Mexico to mines in Indonesia.

"Plains Exploration, based in Houston, produces oil in California, Texas and the Gulf of Mexico, along with natural gas in Louisiana. McMoRan Exploration, based in New Orleans, is developing natural gas resources that lie deep below shallow water regions of the Gulf of Mexico."

Don't get me wrong, I'm all for recapturing past competencies and diversifying into the energy sector. But even analysts like Brian Yu at Citigroup who held fast to his "buy" recommendation were scratching their heads concerning the logic of the acquisitions and the high prices paid.

"We see little if any synergies between the copper mining and oil and gas drilling business to offset the premium valuation paid," Yu wrote. "Investors can get the same diversification in their portfolio at a much lower cost."

FCX, which saw its last quarterly earnings growth drop by almost 22%, moves from being a company with around $3.5 billion in total debt to now having (according to Yu) more than $16 billion. Yu reportedly said this gigantic increase in debt is manageable with some capital spending maneuvers.

The market reaction created an enormous amount of selling of FCX shares on over 10 times average daily volume. FCX's $1.25 annual dividend, which had represented a payout ratio of 37% of the company's earnings, is the first big question mark many investors will face.